One of the most important things our China attorneys do with every contract we write is to determine who exactly is on the other side. This is often no small feat.
When the process goes smoothly, our client instructs us to draft a contract with XYZ Mainland Chinese Company. Our role then involves thoroughly researching this entity to verify its existence and ensure it is authorized by the Chinese government to engage in the activities specified by our client. Once we confirm these details, the transaction typically proceeds without complications. This level of smoothness occurs in approximately 90% of the time.
However, in the remaining 10% of cases, we encounter irregularities. Sometimes, we discover that XYZ Mainland Chinese Company does not exist. When this occurs, we advise our client to query their Chinese counterpart and clarify the entity’s true status. Commonly, the explanation provided is that they are actually XYZ Hong Kong Company or XYZ Taiwan Company, not a Mainland Chinese entity.
This distinction is critical as conducting business in China without a registered Chinese company can lead to illegal transactions. Additionally, dealing with a company registered in Hong Kong or Taiwan instead of Mainland China can leave our client without contractual protections, exposing them to potential risks and liabilities. See Doing Business in China Without a WFOE: Will the Defendant Please Rise. This difference can also mean you have no contractual protection against whatever the Hong Kong or Taiwan company might do. See A Hong Kong Company Is NOT a Mainland China Company.
Recently, our law firm’s China lawyers have observed a new trend where individuals from companies express a desire to be the signatories on deals with foreign companies. When we inquire about the rationale for such arrangements and explain that our clients cannot proceed under these terms, these individuals often claim to be registered as sole proprietors (个体户) with the local tax authorities. Such a registration, if valid, would typically address our concerns; however, we have not once had a situation where this claim has proven to be true.
Engaging in business with an individual who is not registered as a sole proprietor or with a foreign company lacking a proper Chinese entity exposes your company to significant risks:
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Employment Liability: If you transact with an individual not registered as a sole proprietor, you might inadvertently be classified as their employer. This classification obligates you to cover approximately 40% in employer taxes and benefits, plus an additional 25% or so in employee withholding taxes to the Chinese government.
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Legal and Tax Penalties: Engaging in business without the proper local entity may be considered illegal. This could not only subject you to company income taxes but also lead to more severe consequences, such as deportation. For further details, check out Doing Business in China Without a WFOE: Will the Defendant Please Rise.
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Contractual Vulnerabilities: Both individuals and foreign companies without proper registration can potentially breach contracts without significant legal repercussions in China. For instance, should such a party infringe on your intellectual property, pursuing legal action in China would be challenging due to the illicit nature of the contract.
These risks are just one of countless reasons. why our law firm refuses to provide template contracts. Offering such a service, regardless of the price, is too perilous for both our clients and our practice.
